The Corona crisis and the stability of the European banking sector A repeat of the Great Financial Crisis? Bertelsmann Stiftung Repair and Prepare Strengthening Europe May 2020.

Eich, Frank and Küspert, Theresa and Schulz, Philipp (2020) The Corona crisis and the stability of the European banking sector A repeat of the Great Financial Crisis? Bertelsmann Stiftung Repair and Prepare Strengthening Europe May 2020. UNSPECIFIED.

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Abstract

The Corona crisis1 has had a devastating effect on the global economy and could end up being worse than the Great Financial Crisis (GFC). Some commentators have already suggested that the decline in economic activity could be the most marked for several centuries. Unlike the GFC, the Corona crisis was triggered by an external shock. Govern- ments responded to this shock by offering liquidity to the real economy, either directly or indirectly by guaranteeing new bank lending. So far European banks have weathered the storm but will they be able to withstand a prolonged economic down- turn? This paper suggests that the fortunes of European banking systems will depend on the economic recovery we experience. If we witness a “V-shaped” recovery as cur- rently forecast by the European Commission, for example, then banks in the majority of EU member states might be able to survive unscathed. The picture could look very dif- ferent if the recovery turns out to be more sluggish though. The paper suggests that capital ratios – one of the key benchmarks used to assess the stability of banking systems – could drop dramatically in a number of member states such as France and Spain to well below what super- visors generally consider to be “sound” even under stress conditions. With the situation looking less severe in other member states such as Germany or the Netherlands, this could renew political tensions seen last during the euro area sovereign debt crisis. The paper is structured as follows. Section “The Corona crisis” presents the latest economic forecasts and con- trasts the current crisis with the GFC. In Section “Could the Corona crisis undermine the financial stability of the Euro- pean banking sector?” the paper draws on the results of the 2018 EBA adverse stress test. Comparing the 2018 EBA adverse scenario with a plausible “ticked-shaped” recov- ery post-Corona, the paper presents illustrative impacts on capital ratios in a selected number of EU member states. Section “Concluding Comments” looks at the role of Euro- pean-wide policy responses to deal with the crisis and what the Corona crisis might mean for the future of the EU’s Banking Union and Capital Markets Union.

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